USALLIANCE Blog | Your Financial Wellness Ally | USALLIANCE Financial

The Anatomy of a Mortgage Payment

Written by USALLIANCE | Nov 4, 2024 1:15:00 PM

Trying to understand your mortgage payment can be like trying to decode a secret language. Last month, we went over key mortgage terms to help you understand some of the most essential terms. Now, let’s take the next step and go through your mortgage payment in a bit more depth so you can understand the ins and outs of it all. In this article, we’ll take a look at the different components of your mortgage payment, explain how it gets calculated, and offer tips for managing your mortgage payments effectively.

Principal

The principal of your mortgage is the amount of money you borrow from your lender when buying your home. A portion of each mortgage payment that you make goes toward paying down this principal balance. In the early years of your mortgage, a smaller portion of your payment goes toward the principal while most goes toward interest. As time goes on, though, this balance shifts, and an increasing amount of your payment goes toward the principal balance.

Interest

Interest is the cost of borrowing money from your lender and is calculated on the outstanding principal balance. It’s typically expressed as an annual percentage rate (APR). The interest rate you get depends on several factors, including your credit score, your down payment amount, and the current market. There are two main types of interest rates: fixed and variable. A fixed-rate mortgage keeps the same interest rate for the life of the loan, while a variable-rate mortgage can change over time based on market conditions. While a fixed-rate mortgage offers more stability, a variable-rate mortgage can offer the possibility of lower costs over time. It’s important to consider your own personal factors when choosing which path you want to go down.

Property Taxes

Property taxes are levied by local governments and are based on the assessed value of your property. These taxes fund essential services in your community, like schools, police and fire departments, and road maintenance. The amount of property taxes you’ll pay varies widely by location. Lenders will calculate your annual property tax amount and divide by 12 to determine how much you owe each month. These numbers are estimates, and you may end up owing an additional property tax payment (or receive a refund if you’ve overpaid) at the end of the year.

Homeowners Insurance

Homeowners insurance protects your property and belongings from damage or loss due to events like fires, storms and theft. Most lenders require borrowers to carry homeowners insurance, so your choice will not be whether to get insurance, but how much coverage to purchase. The amount of coverage needed can vary drastically from situation to situation, and homeowners insurance policies can be customized in a large variety of ways. Some coverage you may need will require additional insurance as it’s generally not covered by homeowners insurance policies, such as natural disasters and certain repair/maintenance costs.

Private Mortgage Insurance

If your down payment is less than 20% of the home’s purchase price, your lender will likely require you to carry private mortgage insurance (PMI), which protects the lender in case you default on your loan. The cost of PMI varies, but typically ranges from 0.3% to 1.5% of the original loan amount per year. Once you have built up 20% equity in your home, you can usually request to cancel PMI. The lender generally arranges PMI with a private insurance company – PMI protects the lender, not you.

Tips for Managing Mortgage Payments

  • Budget for your payments: Create a budget that includes your mortgage payment and other homeownership costs. This should go without saying but it’s absolutely vital that you ensure you have your mortgage payments accounted for each month. The cost of not doing so could be losing your home!
  • Refinancing: If interest rates have dropped since you got your mortgage, consider refinancing. Refinancing essentially replaces your current mortgage with a new one that has a new rate, term, or both. Refinancing your mortgage can lower your interest rate and/or monthly payment and is also a way to switch from a variable to a fixed-rate mortgage. You can even change lenders when refinancing. Remember that you’ll need to pay closing costs, so if your goal is to save money, make sure you consider those costs in your calculations.
  • Extra payments: Making extra payments toward your principal can help you pay off your mortgage faster and save on interest paid over the life of the loan. There are many free calculators available online that can help you figure out how extra payments will impact the bottom line of your mortgage.

Understanding the anatomy of a mortgage payment is essential for managing your finances. For most people, your mortgage is among the biggest investments in your entire financial portfolio, so managing it properly is key. Knowing the details of the different aspects of your mortgage payment can help you understand how to use each part of your payment to your advantage. Use this guide to learn about the different components of your mortgage, why they matter, and how to manage your payments effectively so that you can focus on the most important part of getting a mortgage in the first place – turning the house that you bought into a new home for you and your family.